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The antidote to a post-pandemic great recession

Steven Hail

Classical economics would prescribe decades of austerity to pay off the levels of government spending seen in the COVID-19 pandemic. But there’s another way, say modern monetary theorists. Dr Steven Hail, Research Scholar at the Global Institute for Sustainable Prosperity, and Economics Lecturer at the University of Adelaide, explains.

A recent New York Times Best Seller, The Deficit Myth: Modern Monetary Theory and the Birth of the People’s Economy, by Stephanie Kelton, who is a professor of economics and public policy at Stony Brook University and a senior economic adviser to senator Bernie Sanders, suggests that a new approach to economics provides the foundation for building a better economy for the post-COVID era.

The policy responses to the pandemic from the world’s governments have already confirmed many of the things modern monetary theorists like Kelton have been saying about the economy for years, have helped to bring their work to prominence and have promoted debates about its significance.

Monetary sovereigns

Take Australia, for example. In March, when the scale of the crisis first became clear, the Morrison Government quickly announced a set of proposals aimed at supporting the economy costed at well over $200 billion Australian dollars (A$).

Not the sort of thing anyone would have expected from a government that had spent years talking about the need to return its budget to surplus (i.e. bringing in more than it is spending). But clearly the only way to avoid economic catastrophe was to spend, and spend big, forgetting yesterday’s rhetoric.

The Great Depression in the 1930s had devastating effects in both rich and poor countries. Personal income, tax revenue, profits and prices dropped, while international trade fell by more than 50%. In the US unemployment rose to 23% and in some countries rose as high as 33%. (Credit: US National Archives and Records Administration,

You might imagine the government would have to look to financial markets, or to foreign investors, before it could start spending such a sum of money. This, however, is not the case. Government debt, when it’s issued, can only be purchased with Australian dollars in the private banks’ accounts at the country’s central bank, The Reserve Bank of Australia (RBA). The same thing is true, incidentally, of taxes: they can only be paid using money in bank reserve accounts. In early March, there was only about A$30 billion in total sitting in these accounts. It would have been impossible for the government to borrow the dollars it was planning to spend from the private sector before going ahead with its spending—those dollars didn’t exist.

It’s important to understand that, where money is concerned, the government and central bank are in a completely different position to the rest of us. You and I are currency users: we need to earn or borrow dollars before we can spend them. If we borrow too heavily we can get into trouble, and even end up bankrupt. But, in the way our monetary system works, the government can’t go bankrupt as it’s the monopoly issuer of our currency.

Before the pandemic, the government was spending about A$1.5 billion a day, and every one of those dollars was a new dollar. So the government doesn’t actually need our money; we need the government’s money (for a variety of purposes, including the payment of taxes). But taxes don’t pay for government spending, that’s not their function.

The main role of federal taxes is to limit inflation (the rising price of goods and services). Taxes take dollars from the private sector, limiting our ability to spend; this instead creates space for the government to spend without risk of driving prices up.

If the government taxes less than it spends, we say it’s running a ‘budget deficit’. This is nothing to be alarmed about. All a government deficit represents is a contribution the government has made to private bank accounts.

Funding the deficit, once it has been authorised by parliament, simply involves a few keystrokes on a computer.

There’s nothing more to it than that.

Modern Monetary Theory economists describe governments like Australia’s as ‘monetary sovereigns’. A monetary sovereign government issues its own currency, has a floating exchange rate, and has no foreign currency debt. Such governments can spend too much and push up inflation, as they face real constraints determined by the productive capacity of their economy, but they can never run out of their own currency – with no purely financial constraints.

According to World Bank forecasts, the global economy will shrink by 5.2% this year, representing the deepest recession since World War 2, with most economies experiencing the highest per capita output decline since 1870. (Credit: World Bank,

Understand this and you will see why the Japanese government had no problem paying for a stimulus package this year, despite having far more debt than the Australian government; and why the UK government also faces no financial constraint, despite the debt it already has and the country’s substantial trade deficit (i.e. when a country imports more than it exports). These are monetary sovereigns. You will also understand why Greece, which is not a currency issuer as it uses the euro, and countries like Argentina and Venezuela, with US dollar debts and a recent history of fixed monetary exchange rates, are in no sense monetary sovereigns. They can, and often have, gotten into difficulties. We have nothing in common with them, at least where government debt and deficits are concerned. However, that doesn’t mean that such countries can’t benefit from the modern monetary theory (MMT) doctrine.

Deficits and surpluses explained

As for our government’s debt, it’s better thought of as the net supply of Australian dollars. All it represents is those dollars the currency issuer has spent into the economy and has not yet taxed back out of circulation. It’s not some- thing that ever has to be repaid. It’s not a burden on future generations.

In so far as it’s owned domestically, it is an asset sitting in the people’s pension schemes, with the interest payments on the debt contributing towards their retirement incomes. Government bonds (the mechanism by which governments borrow) do have uses in our monetary system, which I will not go into here [1]; but the government could decide to never issue any more bonds, and this would not limit its ability to spend.

There’s more.

It should be understood that deficits and surpluses cancel out across the monetary system. This means that a government deficit always shows up as some- one else’s surplus. During periods of balanced trade or trade deficits with the rest of the world, a government surplus implies a private sector deficit.

In Australia, this happened under the Howard Government between 1996 and 2007. The government ran surpluses, and the private sector ran large deficits. The extra debt to support the economy was taken on mainly by households, which is why, in 2020, Australia has almost the highest level of household debt in the world – as well as a fragile financial system, and high levels of inequality and unaffordable housing. In economies like that of Australia, it’s not government deficits that are unsustainable; it’s government surpluses.

A central government should seek not to balance its budget, but to balance the economy. And balancing the economy means the pursuit of non-inflationary full employment – the highest proportion of the population in employment before prices start to rise. This outcome was what governments aimed to do during the Keynesian era — 1945 to 1975.

It’s easy to forget just how successful those decades were. In Australia, the unemployment rate hardly ever rose above 2%, with virtually no under- employment or insecure employment. There was no significant inflation problem until the oil crisis, which was temporary and not something the government could control. The economy grew quicker than ever before or since and there was far less inequality than there had been in the 1920s or is now.

We can’t return to the 1960s, and we wouldn’t want to. The economy, technology, institutions, and society itself have changed in a multitude of ways. There is a different monetary system today, providing governments like our own with much more freedom of action than that Australia’s post-War Prime Minister, Robert Menzies. The labour market is completely different. MMT economists recommend the use of a federal jobs guarantee – where the state promises, as an employer of last resort, to hire unemployed workers to achieve and sustain full employment -rather than a return to a broad Keynesian stimulus, because the old approach wouldn’t work today.

The second Keynesian revolution

Many other differences exist between traditional Keynesian economics and Modern Monetary Theory. And yet there are enough similarities for us to regard MMT as, essentially, a second Keynesian revolution. Much that was taken for granted about economic management 100 years ago was challenged in the 1930s by Keynes. Something similar is happening now. The idea that central banks should be left to manage the economy is up for debate. The notion that governments in countries like Australia should balance their budgets or seek to run surpluses is rejected by today’s revolutionaries.

If the second Keynesian revolution is successful, journalists and economists will focus on inflation risk when discussing federal budgets, and will cease to talk about budget ‘black holes’ or debts they claim future generations will have to repay. If a deficit is not inflationary, and if it supports the economy at full employment, its size won’t matter. The economic narrative will then shift to the deficits that really matter, particularly the jobs deficit and the climate deficit. Then we can focus on what it will take to build a better and more sustainable economy after the COVID-19 pandemic than the one that preceded it.

This pandemic has brought our economies to their knees; it’s through stimulating investment, as opposed to what may be describes as austerity-fueled starvation, that we’re going to get them fighting fit again. A Green New Deal may well be the perfect mechanism by which to do that.

[1] This is far from the only issue which I have not addressed in this article. The role of a federal job guarantee in delivering sustainable full employment is another one, as is the role of the private banks and the attitude of MMT economists to financial regulation. Kelton’s book is an excellent starting point, if you are curious to know more about this controversial new school of thought.

Source: Struggles from Below, 5 Aug 2020

Dr Steven Hail is an ERA member, and an economics lecturer at Adelaide University.

Ed Comment: Uses of government bonds in our monetary system were discussed in the recent paper Federal Debt and Modern Money by Steven Hail and David Joy ( see )

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